Continued stock market volatility and an uncertain economic outlook are likely to dissuade many investors from buying stocks at the moment. There is a risk of experiencing losses in the short run, as containment measures contribute to rising unemployment and GDP contraction.
The father of value investing, Benjamin Graham, experienced several similar scenarios during his investment career. His ability to manage risk, go against the views of his peers and buy stocks during the most challenging periods for the economy are key reasons why he was able to outperform the stock market over the long run.
Managing risk
The uncertain economic outlook means that many companies are set to report disappointing financial performances in the current year. Some businesses may also deliver falling profitability in future years, should the economy’s recovery prove to be slow.
At the moment, it is difficult to accurately predict how specific companies will be impacted by an economic slowdown. Therefore, there may be more risk than normal of losing money in the short term.
However, in my opinion, the best course of action is to aim to minimize risk through buying quality companies with strong balance sheets and sound fundamentals. As Benjamin Graham once said, “Successful investing is about managing risk, not avoiding it.”
Investor sentiment
Investor sentiment has always been highly changeable. Investors first reacted with great pessimism to the prospect of a lockdown, but have recently become more optimistic about the possibility of a fast-paced economic recovery.
Graham suggested that there are common themes that occur during every bear market, such as changeable investor sentiment patterns, which value investors can use to their advantage when buying stocks:
“Though business conditions may change, corporations and securities may change, and financial institutions and regulations may change, human nature remains the same. Thus the important and difficult part of sound investment, which hinges upon the investor’s own temperament and attitude, is not much affected by the passing years.”
Opposing views
It can be tempting for value investors to seek the views of their peers during an economic crisis. Losing money due to stock price falls can test the mental strength of even the most experienced value investors.
However, the stock market’s recovery from past bear markets has often commenced when investor sentiment was at its most pessimistic. Therefore, ignoring the investor consensus and focusing on company fundamentals could be a means of capitalizing on low valuations and preparing your portfolio for the next bull market.
Going against the views of his peers was a fairly common occurrence for Benjamin Graham, who once said, “An intelligent investor gets satisfaction from the thought that his operations are exactly opposite to those of the crowd.”
Buying at uncertain moments
Many investors may decide that it is a good idea to wait until the outlook for the economy is more positive before buying stocks. However, by the time that situation occurs, the valuations of a wide range of companies may already reflect an improving economic outlook through higher prices.
Therefore, investing when the prospects for the stock market are at their bleakest could allow value investors to access the most attractive valuations ahead of a recovery. This strategy may not yield high returns in the short run, but it has been successful in past bear markets, as noted by Graham:
“The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.”
Read more here:
- Howard Marks on Managing Your Portfolio in a Crisis
- Seth Klarman on Investing in Volatile Market Conditions
- 4 Reasons Why Charlie Munger Outperforms the Stock Market
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